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Creating a sustainable Victoria

In September 2010, Melbourne City Council implemented a scheme to retrofit commercial buildings in the City of Melbourne. This article provides some valuable insights into the benefits of the scheme and how it is to be implemented.

Improving the environmental efficiency of commercial buildings - a retrofit

The purpose of the scheme is to improve the environmental efficiency of commercial buildings and to assist commercial buildings to achieve an improved NABERs rating.

Under the scheme, Melbourne City Council partners with a financier to provide funding to owners of approved buildings to undertake specific works designed to improve the energy, water or environmental efficiency or sustainability of the building.

Such funding arrangements are documented in an “Environmental Upgrade Agreement” (EUA) which has as its base a pro forma form of agreement which is available from the Melbourne City Council website.Is the building eligible?

In order to be eligible for such funding, buildings must be approved by the Sustainable Melbourne Fund.

Who are the primary parties?

An EUA typically has three primary parties, being:

the Melbourne City Council (known in the EUA as “MCC”);

the financier (known in the EUA as the “Lending Body”); and

the owner of the land on which the relevant building is situated (known in the EUA as the “Owner”).

However, others can be party to the EUA if the primary parties consider that such additional parties are required to be party to the EUA.

Key components

In essence, the EUA contains the following key components:

the Lending Body agrees to provide a loan to the Owner to complete environmental upgrade works in accordance with set plans and specifications. The loans normally provide for a competitive and fixed interest rate with a repayment period of up to ten years or more;

the Owner repays the loan to MCC (on behalf of the Lending Body) by way of a special charge known as an Environmental Upgrade Charge levied by MCC on the land on which the relevant building is situated – no other refinancing requirement applies. The loan normally also "runs with the land" which means that the loan stays with the property when it is sold; and

the charge payments received by MCC are then passed on by MCC to the Lending Body in accordance with the terms of the EUA.

Matters to note

Security

Traditional security (such as a mortgage of land or a general security agreement to the Lending Body) is not part of the structure of the EUA.

Rather, the Environmental Upgrade Charge levied on the land by MCC “secures” the loan provided by the Lending Body and may be enforced by MCC in a manner and a timeframe that is consistent with the process that it would adopt to recover and enforce its rights for payment of other rates and taxes under the Local Government Act.

Accordingly, for a Lending Body, it is important to understand that the Lending Body does not have any direct recourse to the Owner for repayment of the loan. The Lending Body may only rely on MCC enforcing its rights under the Environmental Upgrade Charge for any nonpayment.

Third party financier

In some cases, an Owner may also have existing facilities (such as working capital or development facilities) with its own Bank or other financier (third party financier).

As security for the provision of such facilities by a third party financier, the Owner may grant security in favour of the third party financier (such as a mortgage over the land on which the relevant building is situated and a general security agreement over all assets of the Owner).

In such a situation, where an Owner has entered into or proposes to enter into an EUA, it is important for the third party financier to understand that the Environmental Upgrade Charge levied by the MCC has first priority over a mortgage of land or general security agreement given by the Owner to such third party financier over the property.

It is therefore important that the third party financier understands and is comfortable with the terms of the EUA.

Matters which a third party financier should be aware of

In the circumstance where a third party financier proposes to lend money to an Owner with an existing EUA, such third party financier should also be aware that under the EUA, the Owner may not:

create an encumbrance over the land on which the relevant building is situated (including a mortgage of land or general security agreement in favour of a third party financier) without first giving notice to the Lending Body and the MCC; and

deal with its rights under the EUA (such as grant a security interest over such rights) without the prior written consent of each other party to the Agreement (including the MCC and the Lending Body).

A third party financier should ensure that such notice and/ or consent is provided prior to the third party financier taking security from the Owner.

Care should be taken not to breach covenants with any existing third party financier

In the circumstance where an Owner has existing loan and security arrangements with a third party financier and proposes to enter into an EUA, it is likely that entry into such EUA without the consent of the third party financier will likely breach any covenants in the security and loan documents which prohibit or restrict the Owner from incurring indebtedness and, depending on the wording of such covenants, may also breach covenants restricting dealings with the Owner’s property or negative pledge covenants.

Owners will therefore need to ensure that the consent of an existing third party financier is obtained prior to the Owner entering into the EUA.

Owner may pass costs of upgrade onto the tenant

Often as part of leasing arrangements, tenants are required to pay to landlords a portion of the outgoings attributable to the leased area. Such outgoings would typically include energy costs and council charges. Accordingly, under the EUA, provided the tenant has consented, the Owner may pass onto the tenant a portion of the Environmental Upgrade Charge, in accordance with the portion of outgoings payable by a tenant under the lease.

If the tenant refuses to provide consent, the Owner will need to consider whether it does not wish to proceed with the EUA or whether it is prepared to fund the additional liability.

Benefits to all parties

The rationale behind the scheme is that funding is provided to building owners for a longer term and at a lower interest rate than if such building owners were to seek independent finance for such works. Once in place, it is the intention that over time the resulting savings from the energy usage will effectively pay for the costs of the upgrades, thereby resulting in benefits to all including the environment.

Takeaway messages

The benefits of using EUAs include:

competitive fixed interest rates with a repayment period of up to ten years or more

the loan is repaid by way of a special charge on the land and where the land is sold then the loan will, except in special circumstances, "run with the land".

Actions to consider

If you are a third party financier being asked to consent to an EUA, then it is important to understand the ramifications of the EUA, its possible effect on the value of the property and that the Environmental Upgrade Charge to MCC will be a first ranking charge on the property.

If you are a borrower, it is important to consult with and obtain the consent of your third party financier prior to entering into any EUA.

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